INCOME TAXATION LOSSES AND BASIC INCOME TAX PATTERNS

INCOME TAXATION LOSSES AND BASIC INCOME TAX PATTERNS

1. Losses and Basic Income Tax Patterns Lesson 8

2. Losses represent reductions of resources due to unintended destruction or deprivation of things.

3. Kinds of Losses 1.Ordinary Losses – are usually incurred in relation to trade, profession or business, property used in business, and profit-seeking transaction incidental to business. These are deductible to gross income. 2.Capital Losses – are incurred in relation to capital asset transactions. These are resources not used in business. Capital losses area deductible only from capital gains. 3.Special Kinds of Losses – are incurred not related to ordinary business transactions or capital assets transactions. Losses from sale or exchange of property between related taxpayers. Wagering losses Losses due to voluntary removal of property such as building, machinery, etc. Losses of useful value of capital assets due to some change in business conditions Abandonment losses in petroleum operations

4. Requisites for Deductibility of Ordinary Losses 1.The loss must be actually sustained in a closed and completed transaction 2.The loss must be that of the taxpayer and incurred in trade, profession or business 3.The loss must be compensated by insurance or other forms of indemnity 4.If a loss results from casualty, robbery, theft or embezzlement, the loss must be recorded to the BIR from 30 days to 90 days from the date of its discovery.

5. Losses not allowed by Law as Deductions 1.Loss on voluntary removal of building on land purchased with a view to erect another building 2.Gambling losses not covered by gambling gains 3.Capital loss not covered by capital gains 4.Losses from exchanges of property in corporate readjustments 5.Losses from illegal transactions 6.Losses from exchanges of property where the property received is not substantially different from the property disposed of 7.Losses not incurred in trade, profession or business or in any transaction entered into for profit 8.Losses from sales or exchanges of property between related taxpayers

6. Partial Loss If the loss is partial, the deductible loss is the lower amount of the replacement cost or the book value of the asset’s damaged portion. At the time of loss, such amount shall be reduced by the amount of insurance recovery.

7. Nondeductible Loss/Excess of Replacement Cost The nondeductible loss in partial loss shall be treated as additional cost in determining the new cost basis subject to depreciation.

8. Loss with Insurance Recovery Any amount received as a loss recovery from insurance company shall reduce the deductible loss. When the insurance proceeds are greater than book value of assets destroyed, then that will be a taxable gain.

9. Net Operating Loss This term shall mean the excess of allowable deduction over gross income of the business in a taxable year. For the taxation purposes, the net operating loss companies only of operating expenses and losses that are allowed by the law as deduction from gross income.

10. Net Operating Loss Carry-Over ( NOLCO ) It shall mean the excess of allowable deductions over business gross income in a taxable year. NOLCO and any item of incentive deduction allowable under in any special law are not part of the itemized deductions.

11. Taxpayers entitled to deduct NOLCO 1.Individual taxpayer’s engaged in trade or business or in the exercise of his profession 2.Domestic and resident foreign corporations subject to normal income tax 3.Special Corporation subject to preferential tax rates such as private educational institutions, hospitals, and regional operating headquarters

12. Persons not entitled to deduct NOLCO As a rule, any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction.

13. NOLCO for Business Combination Merger – absorption of a corporation by another corporation, the latter retaining its own name and identity and acquiring the assets, liabilities, franchises, and powers of the former, and the absorbed corporation ceasing to exist as a separate juridical person. Consolidation – extinguishment of two or more corporations resulting to the creation of a new corporation taking over the assets and assuming the liabilities of the said extinguished corporations.

14. NOLCO in the Tax Return and Unused NOLCO The unused NOLCO shall be presented in the Notes to the Financial Statement showing in detail the taxable year in which the net operating loss was sustained or incurred, and any amount thereof claimed as NOLCO deduction within three consecutive years immediately following the year of such loss.

15. Income Tax System The Philippine uses several types of income tax system. Taxpayers with different types of income are required to adopt the following: Global Income Tax Gross Income Tax System Schedular Tax System

16. Global Income Tax System This income tax system is a combination of gross compensation income and/or net income from business, trade or profession to arrive at the total income subject to tabular tax rates. In other words, global income tax system employs the grouping of similar incomes from all sources and subjecting them to a single tax rate or progressive graduated rates.

17. Gross Income Tax System The taxpayer’s income tax is fixed or computed based on the gross income. The usual allowable deductions are completely disregarded in computing this income tax.

18. Schedular Income Tax System Since income taxes are either computed based on global tax system or gross income tax system, their filing and payment should be accomplished with separate BIR form as required per category of income.

19. Basic Summary of Philippine Income Tax

20. Groups and Sources of Income Taxpayer 1.Individuals 1.Citizen Resident citizen (taxable in and out) Nonresident citizen (taxable in) 2.Alien Resident alien (taxable in) Nonresident alien doing business in the Philippines (taxable in) Nonresident alien not doing business in the Philippines (taxable in)

21. 2. Corporations and Partnerships Domestic corporation (taxable in and out) Resident foreign corporation (taxable in) Nonresident foreign corporation (taxable in) 3.Estates and Trusts (taxable as individual taxpayer)

22. Summary of Groups of Income

23. Deductions from Business Income Itemized allowable deductions (business expense) OSD – 40% of gross sales or gross receipts for individuals and 40% of gross income for corporations

24. Personal Exemptions Basic exemption of 50,000php of each individual taxpayer Additional exemption of 25,000phh for each dependent child, maximum of 4 children

25. Collection Points of Income Tax Collection Point Income Income Tax At source (collected before the income is received by earner) Compensation income   Passive income within: Sale of real property (capital asset) Sale of share of stocks (sold outside stock exchange) Creditable withholding tax   Final withholding tax Quarterly Business income: Trading/merchandising, manufacturing, servicing, farming, leasing, and construction Quarterly income tax Annually Compensation income Business income Gain on other capital assets Passive income earned outside Annual income tax, reduced by creditable withholding tax

26. Creditable Withholding Tax – refers to the income tax withheld by the employer before the earner receives the net proceed of his income. The amount withheld represents an estimated portion of the total income tax for the year. This tax is called “creditable” because it is deductible from the total actual income tax due computed at the end of the taxable year. Final Withholding Tax – is also an income tax withheld from the total income before the earner receives the net proceeds of his income. This tax is called “final” because it is not allowed as deduction from the total actual income tax due at the end of the year.   Quarterly Income Tax – is paid quarterly by those who are engaged in business/self-employed. This income tax is also a creditable tax at the end of the year.   Annual Income Taxes – are normal taxes that are usually 30% for corporations and 5% to 32% for individual taxpayers. These taxes are paid at the end of the taxable year and usually reduced by the creditable taxes.

27. Minimum Corporation Income Tax – is an income tax of 2% based on the gross income of corporation that still incurs losses or reports minimal income tax even after the 3 rd year of business operation. The MCIT is observed starting from the 4 th year of the business. Capital Gains Tax – is generally an income tax on sale of real property and shares of stocks classified as capital assets.

28. Basic Matrix of Income Taxation Taxpayer Income Business Expense Personal Exemption Tax Rate Individual         Resident Citizen Within and outside         Compensation Yes Normal   Business income Passive income outside Capital gain not subjected to final tax       Yes     Excess over compensation       Normal   Capital gains: Sale of real estate Sale of shares of stock             Final Tax   Passive income (within) Final Tax Nonresident Citizen Resident Alien Within Only         Compensation Yes Normal   Business income Capital gain not subjected to final tax     Yes   Excess over compensation     Normal   Capital gains: Sale of real estate Sale of shares of stock               Final Tax   Passive income (within)       Final Tax Nonresident Alien engaged in Business All income within Yes Reciprocity Normal

29. Nonresident Alien no business All income within Final Tax Corporations         Domestic Corporation Within and outside         Business income Capital gain not subjected to final tax     Yes         Normal   Business Loss MCIT   Capital gains: Sale of real estate Sale of shares of stock             Final Tax   Passive income (within)       Final Tax Resident Foreign Corporation Within only         Business income Capital gain not subjected to final tax   Yes       Normal MCIT   Capital gains: Sale of real estate Sale of shares of stock             Final Tax   Passive income (within)       Final Tax Nonresident Foreign Corporation All income within Final Tax

30. Comparison of Individual and Estate/Trust Taxpayers  

31. Comparison of Corporation and Partnership Taxpayers

32. Income Tax Return and Filing A. Individual, employed and not doing business If an individual is employed with only one employer during the taxable year, the corresponding withholding tax every month for the whole year will be accurately deducted. Employer will furnish the employee with form 2316 which will serve the same purpose as that of BIR form 1700. BIR form 2316 is a sworn declaration of the employer of the compensation payment to an employee. B. Individual, employed with several employers during the year, not doing business Under this case, the individual taxpayer is required to accomplish form 1700 and attach to it the form 2316. C. Individual, employed and doing business Under this case, the taxpayer’s income tax return should be reported in BIR form 1701Q for the first three quarters and BIR form 1701 for the annual income tax return. Corporation and partnerships D. Juridical persons engaged in business are required to accomplish BIR form 1702Q for the first three quarters and form 1702 for annual tax return.